Transcript of an Address at the Council on Foreign Relations

By First Deputy Managing Director, John Lipsky
New York, New York
May 8, 2008

TOM KEENE, MODERATOR: I have the great pleasure of moderating today. I'll keep my comments short. We've extended Dr. Lipsky's comments, and I've extended them even further than the extension, because of these important times.

We welcome you to today's Council on Foreign Relations meeting—part of the C. Peter McColough Series on International Economics, and of course, presented by the council's corporate program and the Maurice Greenberg Center for Geoeconomic studies. The next meeting is June 4th. Hernando de Soto will be here for that.

The usual Blackberry warning—messages, alarms, the rest of it. This meeting is on the record, which is important because of these issues at hand. Just this morning on the Blackberry—the Bloomberg Blackberry thing—I saw Argentinean export battles at the Brazilian border, Malaysia exporting—Thailand, rather—exporting to Malaysia rice. We have this issue of this tragedy in Burma and India has shutdown some of their futures markets with these challenges on inflation.

I will dispense with the usual biography, as I'm sure all of you in the room are aware of John Lipsky's accomplishments. I will simply say that my joy in working with Dr. Lipsky has been the concision of the Wesleyan and Stanford thinking and his ability to get to the distinction of the moment. And certainly, there are many critical distinctions to be made of the economics and the political economics of this moment.

Without further ado: John Lipsky. (Applause.)

MR. LIPSKY: Well, thanks, Tom.

And thank you all for getting up so early on a drizzly Thursday morning here in New York.

I have some formal remarks and then we will have a conversation. I look forward to turning this into a conversation.

Well, it seems to me that a broad consensus has emerged in recent weeks regarding key aspects of the global economic outlook. In particular, it's widely agreed that global growth is slowing, reflecting among other forces the decline in asset prices—especially the decline and the problems in the U.S. housing market, but more generally, weakening equity market; the associated turmoil in financial markets; plus the rise in energy and commodity prices.

Now, the effects of this slowdown are being felt most keenly in the United States, but growth in all regions of the world is slowing. According to the IMF's latest World Economic Outlook, global output growth will slow by a full percentage point this year to about 3.75 percent and should remain, in our forecast, at a similar pace in the coming year in 2009.

Now, despite this broad consensus about slowing growth, there is significant uncertainty regarding the outlook for inflation. In the past year, weakening global growth—or, sorry, in the past—in the past, weakening global growth typically has been associated with receding inflation pressures. However, this has not been the case during the past year. Rather, headlined inflation is accelerating.

According to our International Financial Statistics, global consumer price inflation is now running at an annual pace of nearly 5.5 percent compared to a sub-4 percent pace over the last few years. This acceleration in headline inflation in large part reflects the impact of higher energy and commodity prices. Nonetheless, this inflation speed up must be taken seriously, as it creates potentially significant challenges to economic stability that could undermine prospects for restoring the combination of solid growth and low inflation that prevailed earlier in this decade.

To put the issue starkly: After a long absence, inflation risks have reemerged as a global challenge. Rising energy and commodity prices are central to these new concerns.

I will focus my remarks today on three questions posed by these developments.

The first is: Does the increase in energy and commodity prices represent a durable, relative price shift, reflecting long-term global demand and supply trends? Because if this is the case, we'll just have to get used to paying higher relative prices for these items; however, unless their prices just keep on rising faster than prices of other items, then this will only represent a temporary boost to the general price level. In this case, policymakers' task will be to accommodate these relative price changes appropriately, minimizing the resulting overall economic and financial disruption. But their principal task would be to prevent any deterioration in long-term inflation expectations. And when we examine the current circumstances, it seems to us that this represents a reasonable characterization of the situation.

Second, however, is the question of whether existing policies have created at least some of the current price pressures. In particular, policies may be causing market distortions that explain both some of the relative price shifts and the resulting inflation pressures. Moreover, the potential for increased supply of those goods whose prices have been rising fastest may require policy support. And in this case, specific policies are available that would tend to ameliorate the recent price shifts.

So our answer to this second question: Are policy measure's either part of the problem or potentially part of the solution? Here, too, we think the answer is in the affirmative.

The third question: Is it possible that the rise in headline inflation is boosting inflation expectations and/or reflects an incipient overheating of the global economy? In other words, is it possible that the current period bears similarities to the early 1970s when rising energy and commodity prices ushered in a period of rising inflation expectations and ultimately sustained inflation pressures?

In this case, however, my Fund colleagues and I are optimistic that this conclusion is not justified—at least not at this time. Nonetheless, a more pessimistic conclusion cannot simply be discarded out of hand. Thus, central bankers and fiscal policy authorities need to pay close attention to potential inflation risks—specifically signs of more general inflation pressures would justify a decisive policy response, lest the impressive gains in global stability attained in recent years be sacrificed.

Now, in these circumstances, the goal of the IMF and its member countries is to return the global economy to a path of strong and stable growth, accompanied by low and stable inflation.

The principal conclusion that I'd like to emphasize today is that achieving this goal in the current circumstances will require a coherent set of policy responses across a broad front. These will include structural measures designed to improve market efficiency, as well as possible monetary and fiscal policy adjustments. The stakes are high and the responsibilities in this effort, inevitably, will have to be shared globally.

Well, let's turn to the first issue. Why, at a time when the global economy is slowing and the largest economy is perhaps on the brink of recession, are energy and commodity prices still so high—and in some cases still rising? Fundamentals, including shifts in demand and supply over the past several years seem to us to provide much of the explanation.

Demand for energy and commodities has remained robust, reflecting especially the strong growth in emerging and developing economies—led by China and India. These large economies' growth is much more energy and commodity intensive than that of the more developed economies. In fact, emerging and developing economics as a group have accounted for about 95 percent of the growth in demand for oil since 2003. The prospect of a continued relatively strong expansion in these economies suggests that demand growth for energy and commodities will remain solid—even as global growth is slowing. And at the same time, the supply responses to rising prices have been disappointing.

For oil, supply projections have routinely been revised downwards in recent years—particularly for non-OPEC oil producers.

Costs associated with investment in new capacity have increased significantly. Market estimates suggest that average field exploration and development costs have doubled, from about $5 a barrel in 2000 to about $10 a barrel in 2007.

Thus, as spare capacity and inventories have dwindled, the oil market has become very highly sensitive to news of supply disruptions and geopolitical events, as we all know. And this has pushed oil prices to all-time highs in real terms, surpassing their previous 1979 peak by more than 15 percent.

In the case of food, supply constraints are also relevant. Agricultural production costs and associated transport costs are responding to rising oil prices. Temporary factors such as droughts and bad harvests in some regions have also played a role. But that said, by historical standards, in real terms food prices are still well below previous peaks.

And with only temporary relief likely, we expect that agricultural prices will remain high for the foreseeable future, as supply responses may require both new investment and policy reforms. And these inevitably will take time.

Hopefully, the inflationary—impulse from higher food prices will wane, even if prices do not retreat significantly. However, this also indicates that the humanitarian challenge of higher food prices will not disappear anytime soon.

And prices of basic metals, which tend to be the most sensitive to business cycle fluctuations among commodity prices, peaked in May 2007 and fell by 20 percent in the second half of last year, reflecting slowing global manufacturing activity growth and a recovery in inventories from very low levels. However, prices have recovered most of these losses so far this year because of supply concerns and, to a lesser extent, the weakening of the U.S. dollar.

So, in sum, the factors underlying the relative price shifts for energy and commodities appear to be fundamental in nature. This means that much if not most of the recent price increases are likely to prove durable, especially if our global growth forecast appears to be reasonably accurate. But these fundamental shifts do not inevitably lead to sustained, faster inflation. This is a task for policy makers to ensure.

Now, turning to my second question, economic policies, as I said earlier, have also contributed to and, in some cases, exacerbated demand-supply imbalances. On the demand side, many emerging and developing countries have adopted policies that hinder the full pass-through of international prices to domestic consumers by subsidizing or capping fuel prices, among others.

Recent IMF research suggests that—a sample of 43 emerging and developing economies, fewer than half allowed full pass-through of the increase in international prices in 2007, compared with three-quarters in 2006.

In these circumstances, prices cannot play their natural role in moderating demand. Of course, policy makers naturally want to buffer consequences to consumers from brusque price shifts.

In the absence of a systematic approach to price adjustments, however, it is political tempting to create new and distorting subsidies that are destabilizing in the long run. And on the supply side, national policies that affect the domestic investment climate influence supply trends.

For example, our research indicates that investment in new oil capacity is higher in countries with better investment climates and strong corporate and sectoral governance. And with respect to food, biofuel policies in some advanced economies are spilling over to the price of key food items, particularly corn and soybeans. IMF estimates suggest that increased demand for biofuels accounts for 70 percent of the increase in corn prices and 40 percent of the increase in soybean prices.

At the same time, oil prices likely would have been higher in the absence of these biofuel supplies. That makes the overall judgment more complicated. However, these subsidies do not promote economic efficiency as an offset to their inflationary impact.

Policies in some emerging economies have also played a role in the run-up in food prices. Lack of investment and extensive government involvement in pricing, in marketing and distribution in some key crop-producing countries has limited the dynamism of their agricultural sectors.

In any case, agricultural productivity is low in many emerging economies. In Asia, for example, industrial productivity is about three and a half times higher than agricultural productivity, compared with two and a half times in Latin America and one and a half times in non-Asian advanced economies. Without a doubt, there is scope for substantial improvement; however, such improvements will require time and concerted efforts.

And more recently, as you've probably seen, export restrictions motivated by the desire to ensure that domestic populations have sufficient food are having negative effects on countries that rely on food imports, including some of the very poorest countries with highly vulnerable populations.

Well, finally, in recent months, financial factors may have played an increasingly important role in the evolution of oil, and commodity prices as well. Our preliminary estimates suggest that low interest rates have a statistically significant impact on commodity prices above and beyond the typical effects of increased demand.

Exchange rate shifts for sure also appear to influence commodity prices when denominated in dollars. For example, the IMF estimates suggest that if the U.S. dollar had remained at 2002 peak through the end of last year, oil prices would have been about $25 a barrel lower, and non-fuel commodity prices about 12 percent lower.

At the same time, of course, IMF analysis indicated that the dollar's adjustment since 2002 will have reduced the currency's earlier overvaluation and therefore should, in the long run, prove to be supportive to a reduction in global payments imbalances. In other words, these issues have to be kept in a global context, or viewed in a global context.

The easing in U.S. monetary policy also has tended to generate and easing in monetary conditions in countries with currencies closely linked to the dollar. In some economies in Asia and the Middle East, rising commodity prices have exacerbated general inflation pressure, while an easing of conditions has made monetary policy overly accommodating. In other words, here too the global context is creating challenges.

So how can these problems best be tackled? In the Fund's view, policies will need to adjust both to the reality of permanent relative price shifts—or at least durable relative price shifts—and in some cases to a broader resurgence in overall inflation. Advanced, emerging, and developing economies alike have a role to play in ensuring that policies do not hinder the restoration of demand-supply balances in commodities markets.

Let me elaborate very briefly on our views regarding appropriate structural policies. First, given that some portion of the latest increases in oil prices appear to be durable, allowing a demand response to the reality of higher oil prices will be crucial to economic success. Indeed, the pass-through of changes in international oil prices to domestic prices would help promote the inevitable demand response to changing market conditions and encourage conservation. At the same time, well-targeted policy support should be put in place to protect the most vulnerable groups.

Second, policies are needed to foster investment in the oil sector, and in the energy sector more broadly. These include efforts by oil producers, particularly those in emerging and developing economies, to ensure that investment regimes are stable and predictable, they encourage greater cooperation and synergies between national and international oil companies, through well-designed partnerships, and facilitate the establishment of an orderly, predictable, and transparent market through improved data dissemination on demand and supply conditions.

Third, efforts to reduce the level of protectionism and subsidies aimed at stimulating biofuels production would remove distortions and allow for greater overall economic efficiency.

And fourth, agricultural policies can be improved in many emerging and developing economies, as well as the advanced countries. Absent sufficient infrastructure to increase cultivation, boost productivity, and to bring agricultural products to the market, supply responses in developing and emerging economies may remain elusive. So this is going to require broad and concerted and sustained efforts.

But macroeconomic policies also will be crucial. In the United States, policy interest rates have been reduced significantly as the growth outlook has deteriorated. But as U.S. growth recovers, development and inflation and inflation expectations will assume greater importance for policymakers. The 2008 fiscal stimulus should help provide some cushion for demand. However, any new fiscal measures should focus on stabilizing key sectors that are vital to limiting downside risks to growth, such as the housing sector and the financial system. In the euro area, the sharp rise in inflation and concerns about potential deterioration and inflation expectations are dampening consumer confidence in spending. The inflation outlooks, appropriately, is central to the ECB's policy considerations.

But policy prospects there could shift, however, if inflation expectations remain well anchored, and slowing growth reduces inflation pressures. And for Japan, inflation—core inflation, remains very low, about 0.1 percent. And given the uncertainty considering growth prospects, Bank of Japan policy is not expected to change any time soon. And for emerging economies with currencies closely linked to the dollar that are facing overheating concerns, macroeconomic policies need to be tightened in response to generalized inflation pressures. In China, for example, movement toward a more flexible exchange rate regime could provide greater scope for effective and stabilizing monetary policy action. Among Middle Eastern commodity exporters, fiscal spending should be aimed at alleviating supply bottlenecks, particularly related to infrastructure that have contributed to the growing inflation pressures there.

With regard to the IMF, we're dedicated to helping our 185 member countries confront the current challenges. The fund's mandate is to promote global financial and economic stability as a basis for sustained global growth and prosperity. The scope of the recent run-up in energy and commodity prices underscores their macroeconomic significance, putting inflation risks, posed by rising energy and commodity prices squarely within the Fund's mandate. And the global scope of these developments also underscores that a successful response will have to be globally consistent and globally coherent.

Of course, the challenges created by these price rises, extends beyond the Fund's mandate, and as a result, we are participating in the UN secretary general's task force on food prices. Within this broader context, and in line with our mandate, we're focusing on several specific areas, including the provision of financial assistance and policy advice to countries that are negatively affected by the latest international price developments. In particular, we're currently active in—we're currently in active discussion with 10 to 12 low-income member countries regarding possible balance payments financing. Of course, we're conducting economic research aimed at better understanding of the cause of these recent energy and food price increases and their impact and ways to alleviate them. And we're also working with others to develop risk management and risk mitigation tools and strategies that could be used by our members.

But the current challenges to global prosperity and progress are potentially serious and contain many novel elements. However, they can and will be surmounted successfully so long as the responses are appropriate, coherent and consistent in the global context. This is a key understanding of the underlying reality of a global economy.

Thank you very much. (Applause.)

MODERATOR: I will go for 10 minutes and then we'll open it up for questions.

Wonderful comments John, and folks, there's a speech from Dr. Lipsky out of Rome, was it, on oil investment that I think is critical. I'll talk about that in a second. Let's talk the blunt instrument of the U.S. dollar, trade weighted major, two deviations down, acceleration lower, the broad dollar that you've just mentioned rolling over from 2002 highs. Is there a political economics here that will involve a more overt effort to reverse this dollar weakness?

MR. LIPSKY: Well, from our point of view—from the Fund's point of view, we look at exchange rates on a broad multi-lateral basis in real effective terms, if you will. From that point of view, the dollar has been, as I mentioned in my earlier remarks, well over-valued from a medium-term equilibrium point of view. And so, the recent decline has been movement towards a more sustainable long-term situation. The problem has been, of course that when viewed on a bi-lateral basis, it may not be true in individual currency pairs. So, for example, when we look at Asian currencies, many of them are substantially undervalued, currencies with countries with whom the U.S. trades substantially. When we look at European currencies, the euro appears to be on the strong side.

We conducted Multilateral Consultations on Global Imbalances in 2006 and 2007, with a group of five key economies—the U.S., the euro area as a group, Japan, Saudi Arabia and China—to address the issue of how to sustain global growth while reducing global imbalances. It was recognized by these participants that producing this result was a shared responsibility and would require both, inevitably, a shift in the sources of growth in these economies and a need for coherent and consistent global policy initiatives that would achieve that end. In April 2007, the five participants promulgated a list of policy initiatives that each of them would take responsibility for in that effort.

The idea—this may seem a bit long-winded, but why I'm going into this in this context, it was exactly recognized that inevitably the conditions were going to emerge that would cause these global imbalances to become reduced. If adequate policy measures were put in place, that adjustment would be a relatively smooth one and would not necessarily involve brusque movements in exchange rates, and movements that would be balanced globally. In fact, not all the policies that were announced or offered as part of that program have been put in place. Among others, of course, that in Asian economies that have been following fixed exchange rate policies have not produced significant shifts in their exchange rates in real-effective terms against a broad basket of currencies. In other words, the failure, so far, to enact all those policies, is producing strains in exchange rates.

The answer to your question, is there something to be done, the answer is, yes. And a roadmap—a clear roadmap already exists and has been adopted, or as been announced by these major economies. What is required is that those policies be put in place with sufficient vigor and focus. Now, these policies, when you read them, are not about controlling exchange rates or intervening except, in those cases, where countries'—or economies have been following explicit fixed exchange rate policies or explicit exchange rate policies.

MODERATOR: We've got a great room of talent here, so one more question from me, and then we'll open it to the floor.

Tell us, John, of going back to the IMF of—and I take this to a microeconomics level, the surgical input to say, Haiti, where you've really had to come in and provide immediate aid. What have you learned about IMF procedure and a changed IMF as they try to apply aid and services to these truly poor and needy nations?

MR. LIPSKY: Well, the Fund has developed a series of facilities that are designed to be able to respond in a flexible and rapid—in some cases, rapid way to the needs of our members. Among other things, we have an external shocks facility that is designed to deal with these kinds of circumstances. For very poor countries, countries like Haiti, we have the Poverty Reduction and Growth Facility, which is a longer-term program for dealing with structural weaknesses in our poorest member economies. So we have the ability to respond quickly to shocks as well as to deal with longer-term issues.

That being said, certainly in the current context and in the context of the development of global capital markets, we're in the process of beginning a rethinking of our facilities to make sure that they're appropriate and adequate in the current environment.

MODERATOR: And to the immediate news, what can the IMF do to initiate aid to the tragedy of the cyclone in Burma? What has happened in the last 24 hours that you've learned about IMF efforts towards Myanmar?

MR. LIPSKY: Well, obviously the immediate need is a humanitarian one of physical supplies, et cetera. But that's not our area of responsibility or expertise. But we are able to respond quickly across a broad front if necessary in these circumstances. Again, the immediate need is more a humanitarian one.

MODERATOR: I think we've got a microphone on the floor. Would you like to start with a question?

QUESTIONER: This won't be on the global system, but more on the food price rises. A couple of years ago when we saw everybody starting to rush into ethanol plants, we realized that there'd be a huge amount of land required—taken out of agriculture production and put into energy production, and that energy was now a close substitute for grains. And we started to wonder, what was more inelastic? The demand for energy or the demand for food? Probably the demand for food. And an analogy started to pop into our mind. Would there not now be a grain cartel arising, if not by conscious choice then implicitly?

And as time has progressed, we've actually seen what is equivalent now to a grain cartel. Now is this—do you view this as a potentially permanent situation or is there expensive land still available that will come into production and eliminate these kinds of shortages? We have countries that are hoarding food, which are like forming strategic petroleum reserves. We have occasional drought, say, in Australia, which is like a Venezuelan oil strike. So is there now such a shortage in food that we effectively have the final producer—the swing producer—the U.S. being in a major controlling role in this? Or is this simply a temporary phenomenon?

MR. LIPSKY: Very good question, very challenging question.

Agriculture's an area in which markets have been subject to government influence, control, distortions, et cetera, for a long time. One of the focuses, of course, of the Doha Round trade negotiations is to attempt to further liberalize the agricultural trade and make it more efficient, and implicitly less subject to—in the long run—to the kinds of distortions that you're discussing.

Specifically with the question of, well, is this inevitable, is there something structural about these—about the weakness of global markets for agricultural commodities—the answer is no. First of all, many of the difficulties you've described—for instance, the thinness of markets—reflect government distortions and policies that should be dealt with.

Secondly, I had the opportunity to attend recently a meeting of the Heads of Multilateral Development Banks and found the discussion turned inevitably to what to do about these issues. And it's very heartening to hear the availability of substantial amounts of arable land of relatively good quality that has fallen into disuse in some cases in areas you might not think about—countries like Kazakhstan and elsewhere where there's real productivity possible. But they will require infrastructure investment. It's not a matter of just turning a switch.

QUESTIONER: So it's not just a Brazil solution—

MR. LIPSKY: No, not at all.

QUESTIONER:—because when I hear interview after interview after interview is it's just Brazil. And you're saying there's more geography.

MR. LIPSKY: Yes, there's much more geography. And as I mentioned in my remarks, it's obvious that there is substantial area for improvement in agricultural productivity. So what I was suggesting in my remarks is that there's reason to hope for real progress here, but it won't come quickly and it will require a concerted effort both to create the markets and to create the productive facilities infrastructure, et cetera. But this is definitely a `mission possible.'

MODERATOR: And I'd point out from a year ago—with Foreign Affairs, as usual, out front again—an article on how biofuels could starve the poor. I think it was remarkably prescient.

Another question.

QUESTIONER: John, talk to me about the risks in your forecast. It seemed to me you had a little bit of optimism for—there were two optimisms in your remarks. One was that aggregate demand in the world really is going to shrink a little bit now. And one risk to your forecast is, that's not so. It might—maybe we're looking at oil prices—all the commodity complex moving. And the other was you thought inflation expectations were remaining well-anchored. When we look past, say, the G5, how much confidence should we really take that inflation expectations are anchored in the industrial core when inflation itself is accelerating in so many countries around the world?

MR. LIPSKY: Good question.

First of all, I would point everyone back to our recent World Economic Outlook publication, in which we discuss that the two outlier risks—principal outlier risks in our view was one on the growth side—that the risks in fact were toward a weaker outcome, not a stronger outcome. What we suggested is that appropriate policies— and with some good luck—that we would avoid that. And hopefully that's right.

The second risk that we pointed to was the one I've discussed today—was the risk of rising inflation pressures. And—so your question is what gives us confidence that these can be dealt with adequately? First of all, what's most important—and I suspect everyone in this room will be familiar with—is that one of the most notable developments of the past decade and a half or so has been the dramatic decline in inflation in emerging market economies and developing economies, that is even much more notable and dramatic than the evening out of inflation in the industrial economies.

And in these countries—in these economies, in part, the improvements represented favorable circumstances instead of favorable circumstances globally, but also a strengthening of the policy formats and focus in these economies. We hope that will prove to be durable. But again, my suggestion in my remarks was this can't be taken for granted. It will require concerted policy effort and policy effort that is coherent.

Obviously this is one of the things that we will be monitoring very closely. I expect all of you will be, to see whether in those cases where broad macroeconomic policy adjustments are needed to reduce inflation pressures, that they will be undertaken. And here, of course, the first line of defense is appropriate monetary policy action where needed. We're optimistic in this regard because it seems to us that the period of relatively low and stable inflation, certainly by comparison with the past, has been associated with good economic performance and has built up support for policies—stability-oriented policies. In other words, I don't think anyone suffers from the illusion that somehow accelerating inflation is good for economic performance.

MODERATOR: Should a central bank of a developing nation apply their monetary policy across all of their inflation, including this in food inflation? Or should they take food out, actually they work with a core constructor more, industrial and real-based economy inflation?

MR. LIPSKY: Well, what I suggested in my remarks is that we thought that the shift in relative prices in favor towards energy and commodities was likely to be durable. And that case simply has to be accommodated. Of course, for some developing economies this is favorable, not unfavorable, for their economic performance. More broadly in that context in the way you put it, there may be, and in my remarks I was trying to suggest, there's an aspect that is durable of these price shifts and must be accommodated. There are microeconomic policies that would alleviate those pressures, could reduce the need for those relative price shifts. But in the long run, the focus will have to be on keeping a core inflation, if you will, low.

QUESTIONER: John, you've given us a very persuasive road map. And my question is, what instruments does the IMF now have to encourage countries to do what they need to do? Some people have even argued the IMF's become almost irrelevant. Because in a world awash with foreign exchange reserves, such as in Asia and elsewhere, the leverage you used to have with fund programs and conditionality doesn't exist. So how do you get countries to listen? And how do you relate to the G7, G8 and maybe the question of China not being even part of the G7, G8 dialogue? How can we re-fix the international institutions to move more effectively in the direction you want to go?

MR. LIPSKY: Well, thank you for that. Those are important concerns and issues. Some of them result from good causes in other words, good economic performance over the past several years, that has, in the wake, for example, of the Asian crisis, allowed countries to build up foreign exchange reserves to improve their current account balances, to put themselves in a situation in which they're much more resilient to external shocks.

On the other hand we are going through a period in which the developing economies, as a whole, have been capital exporters to the developed world. And that's not likely to be a situation that we would want to sustain over a long period of time. You would anticipate that in a well-functioning economy over the medium term that the poorer economies would be capital importers because they would present the best growth opportunities and the best locus for foreign investment.

So let's take a step back. And I think an easy way to look at the challenges from a structural point of view are to reflect that the two big changes of the past decade and a half or almost two decades now has been, of course, let's call it the breakup of the Soviet Union and the re-creation, if you will, or maybe creation in a way of a truly global economy for the first time certainly since World War I. Emblematic of that is the IMF. When it was founded, it was founded with 45 members. And today we have 185 members. The IMF was envisioned and the global system was envisioned to be a global system, but it became such only 15 years ago. And at the same time, we now have a global financial market in a way that probably never existed ever. So dealing with these two realities requires the adjustment of the international systems.

Now, as you're probably aware, one of the things we did, we've just completed successfully for the first time in 30 years a rebalancing of the membership shares, the quota shares, in our institution. And explicitly, that's part of a process that will require several steps in which we're moving towards a rebalancing of the membership quotas toward dynamic economies.

At the same time, we're adapting our own facilities to a world of large-scale, global capital flows. And the implications of this are not completely clear to anyone. After all, who anticipated the degree of disruption and turmoil in financial markets that we've experienced since last August that has underscored both the interconnectedness, if you will, of capital markets and the surprises that they can hold? This has given a whole new impetus to an attempt to both understand and re-engineer our international systems.

One aspect is the work in the Financial Stability Forum. There's the G7. But the point you make is absolutely right. It's clear we need a rethinking of our configuration of our global institutions.

What have we done at the Fund? I mentioned one thing we did. We created the instrument of Multilateral Consultations that allows us to focus on specific issues, form groups of economies to focus on those issues. I think we will continue to do that. Most recently, at our spring meetings, our International Monetary and Financial Committee which is, let's call it, the executive committee of our Board of Governors, and our Board of Governors are the finance ministers and central banks of 185 member countries, held a closed-door, informal, unscripted discussion of the global economy. And it's fascinating to see, of course, that in that context that the concerns expressed differ between industrial and developing countries. The dialogue is fascinating. And it, I'm convinced, will have effect.

Now, finally—sorry for the long answer—you asked, okay, how is the IMF going to influence things? The idea that the IMF's influence rested on making large-scale loans to countries in emergency circumstances is an artifact of the late 1980s and the '90s. It was not inherent to the IMF nor is it typical for the IMF. We got the idea that the IMF's in business to make large loans. We're in business to not need to make large loans. So our goal is to promote the kind of effective dialogue that will produce policies that, I think, increasingly are recognized have to be globally consistent.

QUESTIONER: What is the potential utility and durability of long-term contracts, like that of Southwest Airlines, for jet fuel or, in the early days of nuclear power, the offer of Westinghouse for fixed-price uranium for future decades? How real are such things? And how wide could be the impact?

MR. LIPSKY: That's a terrific question. In essence, one other question I mentioned in my remarks that we're thinking in terms of risk mitigation strategies and techniques and one of the important questions here is, as I have put it before, the Fund, and more broadly the international community, needs to think in terms of three gaps. One, gaps in data where a lack of information leads to bad decisions. Second, gaps in legal or regulatory structures where these gaps create institutional weaknesses and potential failures. And the third is gaps in markets. In other words, to ask the question, why can't we buy insurance against that risk? Is it because we need to take legal action or regulatory action to create the markets? Do the markets require public sponsorship, et cetera?

Because it seems to me increasingly—for example, you've really implicitly asked that question in this context: Why aren't there liquid, long-term futures markets in energy that could be stabilizing? Why are long-term markets so thin such that if you follow this, you know that the futures markets in energy just follow the spot prices more or less rather than providing a real reliable, long-term anchor? These are the kind of questions for which there's no blanket answer and no simple answer but ones that have to be addressed, I think, in an effective way.

And I suspect what we have to realized is that, in many ways, increasingly over the past few decades, and certainly in energy, that the sources of energy are now controlled by governments, or the raw materials for energy is increasingly controlled by governments; hence, the need for a policy context for providing these answers.

QUESTIONER: Which countries do you think are most vulnerable to the current crisis in commodities and inflation?

MR. LIPSKY: Well—I don't want to get into creating any—

MODERATOR: I didn't ask it. (Laughs.)

MR. LIPSKY:—create any news that we don't want to create. But we have—at the time of our recent spring meetings, we, for example, produced a map of the world that shows the impact, by country—of the impact of the rise in food and energy prices. And what you find is that it's quite varied across the globe, in that when you stop and think about it, many countries are food exporters and energy importers; others, energy exporters, food importers.

So it turns out to be quite varied in its direct impact. And in general, the most affected are some of the most vulnerable and poorest economies, many in Sub-Saharan Africa. But even there, the pattern varies country to country. Some of poor countries are energy exporters as well, and have benefited. But that's only one potential source of vulnerability here, which I was trying to suggest in my remarks.

There are other avenues—through financial markets, through its impact on economic activity and inflation pressures. And that's why we have to take a holistic view. But, for sure, we are taking a look or trying to make sure that the most vulnerable have access to sufficient aid. And I think that is one of the goals, of course, of this U.N. task force that I mentioned.

MODERATOR: Sir?

QUESTIONER: Thank you, gentlemen, for the usual lucid and, I would say, optimistic point of view, but optimistic in the sense that events can be shaped.

MR. LIPSKY: Exactly.

QUESTIONER: Let me pick up on your point of policies—right policies and policy interventions. What's absolutely essential in the implementation of that, of course, is the political will. And I would like to put my question much more on the—through that lens, the existence of political will to make these things happen.

You've, sort of, had—obviously, we've had 20 or 25 years of the most rapid expansion of the global economy. It's sort of had three stages. I mean, first the collapse of the dirigist communist system sort of gave a boost to free markets. We then had the triumphalism of the free markets, and that period. And that period, to some extent—when you talk to political leaders all over the world, particularly in the developing world—has sort of seen its end.

And, setting aside the—(inaudible)—, there is a view that says they don't work. We need to be a little bit more interventionist. We need to focus on what's good for us, rather than the global situation. How do you overcome that political vision, particularly at a time when—let's say, the role of the United States on the global economy has, for very understandable reasons, because they're competitive—(inaudible)—that has been reduced. How do you—or, do things have to get worse before a political will arises? (Laughs.)

MR. LIPSKY: (Laughs.) Well, thank you for that—that very good question. Very astute. It seems to me that I guess I tend to view issues like this as a matter of challenge and response. And every time there has been—if we look at the course of the post-war era, post-World War II era, has been one of a series of challenges and responses.

First, the current international order grew out of the lessons of the Great Depression and a perceived need to keep markets open. It was envisioned as a global order, but was born as a divided order, in part. Amazingly, at least in the part of the world in which—that it existed, there was a period of tremendous success in opening markets.

Forgive me, I love talking to the junior associates who, when you talk about things like bilateral clearing accounts in central banks, don't know what you're talking about and assume that the world was always such that if you want foreign exchange you go to your bank and buy it. There's nothing to it. That created a world—at least a partial world, of relatively open markets and success.

More recently—to short-circuit this, we're now in a period, as I've suggested, of what I call "true globalization." And we're still learning the lessons of that, of that period. How do we evolve a global governance in this environment that is effective?

Certainly it takes—it's going to take time, and it takes pushing. But, I'm convinced that the realities will assert themselves in the long-run, that success requires open markets—in economic terms, not just—your question on political will is perhaps a broader one, but at least in the economic and financial sphere, which I think is crucial here—that open markets, a rules-based system, one that is nondiscriminatory, these may seem like abstract concepts, but require a lot of consistent work.

And I'm convinced that despite the strains now that naturally are causing political authorities to look to their own self interest first, it seems to me that the lessons of the year, couple years have been so obvious and so strong that success requires globally coherent, multilateral efforts. None of these issues can be resolved, or success can be achieved by simply looking to your own self interest in a very narrow way. That reality should be palpable.

Now, what that means—what do we do when we get up every day in the morning may not be so clear, but it seems to me that the essence has to be political will to work at it, and to work at creating a system that is perceived by everyone to be inclusive and rules-based and fair. If we can't do that, we're going to be headed for problems. Hopefully, again, the challenges of the last year, or year-and-a-half have demonstrated that clearly.

MODERATOR: Question back here?

QUESTIONER: John, you've spoken about the problem of global imbalances, but I'd like to understand a little better your vision of what a world of long-term macroeconomic balance, as it were, in the world actually means.

Most international trade, of course, is denominated in dollars. It seems to me that if the U.S. didn't continue to supply the world with dollars through a current account deficit, Europe would have to supply the world with euros to trade, or some other country, or coalition of countries would have to supply their currency.

So, it seems to me that imbalance, as it were, is a, is a fundamental component of the way the international economy works now. So, what is your view of long-term balance, as it were?

MR. LIPSKY: (Laughs.) Thanks. An easy question. But let me—let me approach it with a couple—a couple of very simple ideas here.

Look at it this way, when I talk about—what are the source of imbalances? Up until a year ago - the previous five years had been five years of the fastest global growth in four decades. And the balance, at the level of GDP growth, was the best balance ever that we can find. And yet it was accompanied by record payments imbalances.

What was the secret? Well, the underlying reality was there was an unevenness of growth in domestic demand, and that was the source of those imbalances. In other words,put it this way, for the past decade global growth has depended to an unusual degree on the strength of domestic demand growth in the United States. And it seemed inevitable, that if economic success were to be sustained, that that was going to shift.

And in the next five to 10 years, growth in the United States is going to depend, to an unusual degree, on the strength of growth of demand—domestic demand, outside the U.S. And that was going to imply that everybody had to change. The sectoral sources of growth are going to have to shift. And that was the underlying premise of the Multilateral Consultation on Global Imbalances—that it was a shared responsibility.

Now, you asked a slightly different question in that regard, namely: Currency denominations, did this require—does this successful rebalancing of the sources of global growth require a multi-currency world, a single-currency world? And, to be honest, I don't think we have a clear view on that.

But, what is clear is that we ought to create a kind of an environment in which economic efficiency will drive that—and economic actors will themselves drive that answer. In other words, could it be a multi-currency world? Could be. Could U.S.—could this be—could the international role of the euro grow? The RMB? Should that become, over time, an important international currency interest? For sure.

We'll just have to see.

What is clear is that success is going to require globally-coherent and globally-consistent policies. And those can only be achieved, I think, by a multilateral approach towards economic and financial policymaking.